As a business owner, you recognize that having the right equipment is vital to the success of your company, but keeping that equipment running and up to date can be expensive.
Equipment financing can help you grow your business while keeping the cash you need for payroll, rent and marketing costs. Learn how equipment lending works, what the benefits are and how to obtain the right equipment loan for your business.
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What is a business equipment loan?
A business equipment loan, or equipment financing, provides businesses with the funding they need to upgrade or repair the equipment they use for daily business functions. Qualifying equipment includes appliances, vehicles and electronics, such as computers. An equipment loan agreement usually cannot be used for payroll, real estate, debt servicing or other expenses.
After your loan application is approved and you receive funding, you begin making payments on the loan, which includes the total cost of the equipment plus interest over a fixed period. Once you have repaid the term loan in full, you own the equipment.
What equipment loans are used for
Here are some of the most common reasons why businesses take out an equipment loan:
- Heavy equipment. Large dump trucks, shipping rigs and the like fall under this category, and they can easily cost in excess of $100,000. Heavy equipment is necessary for several lines of work, including construction, shipping and manufacturing, and for many companies, the only way to obtain these critical pieces of equipment is through a business equipment loan.
- Restaurant equipment. Industrial kitchens are not cheap. Ovens, stoves, friers, prep tables, industrial dishwashers can all run into the thousands of dollars. Even replacing plates or glassware can be expensive when ordered on a scale necessary for a busy restaurant.
- Construction. Vehicular tools like backhoes or cranes can easily run tens of thousands of dollars. Other construction equipment, such as hand tools and electric tools, may need to be purchased in bulk, driving up costs for small companies.
- Manufacturing. Manufacturing equipment comes in all varieties. Computers for control stations and automatons for dangerous work fall under this purview. According to O'Neal Manufacturing Services, the average cost of manufacturing equipment is between $50,000 and $70,000.
- Office equipment. Equipment for an office may include a multifunction copier, computers, servers, networking equipment, desks and chairs.
What are the benefits of an equipment loan?
According to the Equipment Leasing and Finance Association, 78% of U.S. businesses finance their equipment, regardless of company size and industry. Here are some of the reasons so many businesses choose this type of financing:
- Ownership. Once you pay off the loan in full, you own the equipment. Business equipment loans are especially helpful for larger purchases, such as appliances and furniture, that you can liquidate when you need to upgrade.
- Cash reserves. If you need money quickly, an equipment loan can allow you to direct your cash flow to other business expenses, such as payroll, rent and advertising.
- Revenue boost. If you are confident that the new piece of equipment will increase your sales (e.g., an additional oven at a bakery that enables you to produce more goods to sell), you can increase your revenue while maintaining your working capital.
- Easy approval. While some business loans can be difficult for small businesses to get, equipment loans have built-in collateral, which means lenders are more comfortable approving small business applicants.
- No down payment. Because equipment loans typically use the equipment you purchase with it as collateral, you can often finance 100% of the equipment without a down payment.
- Competitive edge. You must maintain and update your business's equipment if you want to excel against the competition. Equipment financing makes upgrading or replacing equipment more affordable in the near term, as it gives you the flexibility to pay over time.
- Fixed rates. Business equipment loans that have fixed rates allow you to lock in a low interest rate. This may be more cost-effective than a variable-rate loan if interest rates increase during your loan term.
- Bundled costs. Sometimes, new equipment requires professional installation and regular maintenance. An equipment loan can account for these extra costs by bundling them into your loan total.
- Tax breaks. A new equipment purchase is a business expense and can often be written off as a Section 179 deduction. This also applies to equipment that is purchased with an equipment loan. If your equipment qualifies, you can write off 100% of the purchase – up to $500,000 – on that year's taxes, which lowers your tax liability.
- Lower soft costs. Soft costs cover fees and delivery. Depending on the lender, you may be able to get up to 25% of soft costs covered. Check with your lender to see if any soft charges are covered under your particular loan.
- Flexible payments. Does your business revenue fluctuate? Depending on the lender, you may be able to arrange a flexible payment schedule and choose whether to pay monthly, quarterly, seasonally or even annually.
What lenders offer equipment loans?
There are four main places to seek an equipment loan: banks, credit unions, online lenders and equipment vendors. All of the lenders have different terms and loan options.
Choosing a financial institution that you trust and already have a relationship with is your best bet for negotiating favorable payment terms and getting quick approval.
Do business equipment lenders require collateral?
Depending on the loan agreement, it may be possible to use the equipment you are financing as collateral. Then, if you cannot make payments on the equipment, the lender can take over ownership of it.
Alternatively, some equipment loans may require you to sign a personal guarantee or agree to a blanket lien. If you default on your loan payments and you signed a personal guarantee, you must take over the loan payments yourself or the lender will assume ownership of personal assets. Or, if you signed a blanket lien, it gives the lender the power to take your business assets, which may include the equipment you are financing, and possibly other items, if you fail to make the required loan payments.
How do you get an equipment loan?
As with any business loan, there are certain requirements that your business must meet to qualify. Though some requirements may vary depending on the lender, the following requirements are commonplace for securing an equipment loan:
- Credit score. A good credit score is essential for obtaining loans to expand your business. If you have a high credit score, you will receive a lower interest rate and better loan terms.
- Business plan. You will need to supply your lender with a detailed proposal of your company goals, your annual revenue and the number of years you have been in business. Some lenders require borrowers to have been in business a certain number of years and to meet an annual revenue threshold.
- Cash flow. The lender will need a balance sheet that helps to assess your revenue and expenses and determine whether you have enough cash flow to pay your loan. If you don't have an accounting department, consider hiring a CPA to get your paperwork in order, which can boost your chances of getting approved in a timely manner.
- Personal finances. In addition to providing balance sheets for your business, you may need to show information regarding your personal finances.
- Personal résumé. All lenders will appreciate an updated personal résumé with your loan application. It helps you connect with the lender, provides insight into your character and supports your business plan documents.
When you should consider an equipment loan
Assuming you need equipment that is pricey enough to justify a loan, the equipment loan process is favorable for small business owners. It can be easier to demonstrate your need to an equipment loan specialist than to a bank. It also lowers the amount of work necessary on your end.
There are also potential tax advantages to an equipment loan. You might be able to deduct the interest from your taxes, and you can use the loan to lower your net income and net worth without burning through your working capital. The equipment loan may prove to be the means that allows you to get the things you need while keeping an important cash reserve and avoiding being hit hard in tax season.
Should you finance or lease business equipment?
When you are approved for an equipment loan, the equipment you purchase is used as collateral. When you pay off the loan in full, your business owns the equipment.
If you are having difficulty qualifying for an equipment loan, an equipment lease may be an alternative to consider, as it is often easier to qualify for if you have issues with cash flow or business credit. When the lease ends after a fixed time, you can purchase the equipment, renew the lease or end the lease directly from the equipment leasing company.
If you choose to lease, there are two main options: operating leases and capital leases. An operating lease offers a low monthly payment, and you will be allowed to purchase the equipment at the end of the lease for fair market value.
Capital leases require higher monthly payments and mirror the structure of a loan. When the lease is complete, you can purchase the equipment at a low cost, sometimes as low as 10% of the retail price. [Read related article: Equipment Loan or Lease: Which Option Is Right for You?]